The Revised Money Stock: Explanation and Illustrations’

by ALBERT E. BURGER and JERRY L JORDAN

HE BOARD OF GOVERNORS of the Federal Reasons for the Revision Reserve System recently revised the data for currency Seasonal Factors held by the public, demand deposits held by the public, and time deposits at all commercial banks. The Most weekly, monthly, and quarterly economic revision includes semi-annual adjustments for new time series are subject to recurrent seasonal move- benchmark data on nonmember bank deposits and ments which are not related to broader underlying vault cash, and the annual recomputation of seasonal trends. In order to analyze movements in the series adjustment factors which are applied to each of the free of seasonal movements, statisticians have de- basic deposit and currency series. vised methods of identifying seasonal patterns and computing factors which are used to adjust the raw data. The seasonal pattern for a given series may In addition to the semi-annual benchmark and an- change over time for various reasons, so it is desirable nual seasonal adjustments, a major aspect of the pres- to recompute periodically the seasonal adjustment ent revision is the correction of a measurement error factors. The seasonal factors for components of the in member bank demand deposits adjusted. This measurement error resulted mainly from international fi- money supply and related series are recomputed nancial transactions flowing through U. S. agencies annually. and branches of foreign banks, and subsidiaries of Benclnnark.Adji.tstnzents U. S. banks organized under the Edge Act to engage Twice each year insured nonmember banks submit 2 in international banking. their Reports of Condition (call reports) to the Fed- eral Deposit Insurance Corporation. From these re- This note explains the revisions, illustrates their ports the Federal Reserve obtains infonnation on effect on the level and growth rates of money, and nonmember bank deposits and vault cash, Between analyzes their significance for assessing recent mone- such reports the nonmember bank data on vault cash tary actions and their influence on the economy. In and deposits are estimated for purposes of computing the Appendix, a sequence of transactions involving the money stock. The receipt of new call report data Edge Act corporations are presented in T-accounts to provides a “benchmark” for improving the estimated show how the money stock series was underestimated. nonmember bank data. Benchmark adjustments revised estimated nonmember bank deposits downward by $300 million at the end of 1969 and by $900 1 The discussion in this note regarding the effects of trans- million for mid-1970. actions involving Edge Act corporations has benefited sig- Revision~in• Deman.d Deposi.t Calculations nificantly from discussions with and papers made available by Irving Auerbach at the Federal Reserve Bank of New The U. S. money supply series, as compiled and York and Edward R. Fry at the Board of Govemors of the Federal Reserve System. Mr. Auerbach, Mr. Fry, and their published by the Federal Reserve System, consists of respective associates are absolved of any remaining errors. currency in the hands of the public and demand For further discussion of the magnitude of the underestimation of the old money series, and the procedures used in deposits held by the public at all commercial banks. the revision to correct for these measurement errors, see The currency component of the money supply is ob- “Revision of the Money Stock,” Federal Reserve Bulletin, tained by subtracting vault cash of all commercial December 1970, pp. 887-909. 3 2 banks from total currency in circulation. The Edge Act of 1919 amended the Federal Reserve Act 3 permitting the Federal Reserve Board to charter corporations Data for vault cash of member banks are available on a ‘for the purpose of engaging in international or foreign weekly basis to the Federal Reserve. Data for vault cash of banking or other intemational or foreign financial opera- nonroember banks are estimated between semi-annual cnll tions .. .either directly or through the agency, ownership, reports. Data for total currency in circulation are available or control of local institutions in foreign countries daily from Treasury and Federal Reserve statements,

Page 6 FEDERAL RESERVE BANK OF ST. LOUIS JANUARY 1971

5 The demand deposit component of the money domestic commercial banks’ balance sheet. A deposit supply includes only demand deposits held by the of an Edge Act corporation or similar institution is nonbank public, that is, demand deposits at all com- treated by a U. S. bank as an interbank deposit and mercial banks other than those due to domestic com- is therefore not included in the demand deposit com- 6 mercial banks (interbank demand deposits) and the ponent of the money supply. However, the cash items US. Government. Also, “cash items in process of generated by the Edge Act transactions are included collection” and Federal Reserve float are deducted, to in the bank’s total cash items, which are deducted avoid double counting in measuring the amount of from gross demand deposits. demand deposits the nonbank public knows that it holds (and hence influences spending decisions). The following example illustrates the effect of this treatment of Edge Act deposits on the money supply. The reason for deducting cash items in process of collection between domestic commercial banks can When aU. S. bank receives a check to be credited be illustrated by an example: to the account of an Edge Act corporation, the bank enters the amount of the check in a liability account Suppose Mr. A writes a check for $100 on his “due to bank” and also adds the amount to cash commercial bank (CBa). He then gives the check items in process of collection. When computing the to Mr. B who deposits it in his bank (CBb). While money supply data, both the cash item and the “due the check is in process of collection, that is, while to” account are deducted from gross demand deposits. CBb is waiting to receive a transfer of reserves The deduction of cash items is only appropriate when from CBa, the funds involved appear as a demand there is a counterpart deposit in the money supply deposit on the books of both GB5 and CBb. Since data. Hence, it is double subtracting to include the checks do not clear instantaneously, gross demand cash item temporarily created by this transaction in deposits temporarily rise by $100. the total cash items in process of collection to be deducted from gross demand deposits. The money supply series measures the currency and demand deposits which the public knows it The volume of international transactions which holds. Mr. A knows that he has $100 less in his checking account. Therefore, the cash item in process creates these particular “due to” or interbank deposit of collection (the $100 check of Mr. A) is deducted accounts has been increasing rapidly in recent years. to get a more accurate measurement of the money Thus, the old money supply series was subject to an supply series, increasing underestimation. “Cash items” (which appear as asset items in the To correct for this measurement error in the de- balance sheets of banks waiting to receive payment) inand deposit component of the money stock, data are also generated by certain international transac- were collected from U. S. agencies and branches of tions. To the extent that the cash items resulting from the collection of funds relating to an international foreign banks, and from Edge Act corporations, and added to gross member bank demand deposits.7 As a transaction (for example, the borrowing and repayment of Eurodollars)4 are matched by a liability such result, the deduction of total cash items in process of as a demand deposit of a foreign corporation, the 5 computation of the demand deposit component of the The discussion in this article will emphasize transactions involving Edge Act corporations, but the reader should be money supply is the same as for cash items arising aware that the discussion applies to certain other types of in- from purely domestic clearings. ternational institutions as well. 0 This is the same as the liability account “due to domestic However, certain other international transactions — commercial banks” that appears on the balance sheet of a involving Edge Act corporations and U. S. agencies large correspondent bank with which another bank maintains deposits for clearing purposes (see Table I) - These and branches of foreign banks — may not give rise to transactions do not affect the required reserves of the com- deposit liabilities on domestic commercial banks to mercial bank. The “due to” account increases the banks demand deposits subject to reserve requirements, but the offset the international cash items generated on the corresponding “cash item” is subtracted, thus demand deposits subject to reserve requirements are not affected. t See Albert E. Burger, “Revision of the Money Supply ~According to the article, “Revision of the Money Stock,” Fed- Series,” this Review, October 1969, pp. 6-9, and “Revision eral Reserve Bulletin, December 1970, p. 891: “The figures of the Money Supply Series,” Federal Reserve Bulletin, for deposits of Edge Act corporations are readily available October 1969, pp. 787-803, for discussions of the effects of from weekly reports submitted to the Federal Reserve Bank of Eurodollar transactions on the money supply prior to mid- New York in accordance with Regulation IC. For agencies 1969, and a description of changes in Regulation D to and branches of foreign banks, end-of-month deposit figures require certain transactions to be treated the same as other are available from reports submitted to the New York State deposits subject to reserve requirements. Commissioner of Banking. However, it was necessary to

Page 7 FEDERAL RESERVE BANK OF ST. LOUIS JANUARY 1971 collection (including those created by both domestic and international trans- labia I actions) now provides a more accurate Computation of Demand Deposit Component of Money SuppIy~ measure of “member bank demand Old Revised Effective deposits adjusted.”S Series Series Change Gross demand deposits (member banks) $179.1 same

PLUS: Computation of the demand deposit Dcmand cepasits due to component of the money supply for mu’snl sa,ngc banks and fordgr. institutions 30 same a sample week is illustrated in Table Liabilities of specialized I. Although the data in the table are banking nstitut,ens- -——0--- 7.9 -j 7.9 LESS’ approximations of the actual dollar Demano dcpesom au Sn bs,nks 23 8 same changes, they reflect accurately the US. Government demand deposits 5.9 some ~amhitems.n p’octss of colluctior 31.5 same relative sizes of the revisions resulting Demand deposits adjusted (member banks) $1 20.9 $1 28.8 --$7.9 from international transactions rela- PLUS’ Nanmember bank tive to benchmark adjustments. In the demand deposits ad ustt d 38.3 37.1 1.2 sample week, the addition of gross Foreign and internaforsel1 deposit liabilities of Edge Act corpo- deposits at Federai Reserve 0.4 nansc LESS: rations and other international bank- Federal Reserve float - 3.0 - name ing institutions raised demand de’ Total d.jrnond deposit component $156.6 $163.3 -- $6.7 posits adjusted by $7.9 billion. Data J).LT:5 ti’~ ::: tiiilu.,.i ‘~i .li.ll.-——. — ..tl -‘S. s—roi. for nonmember bank deposits, based si.s-. Ei..,. \ .li r.’ nil ‘inns.. os— In—p lOL- .. fl~!. ‘irs’ .‘. LI—i lx-,. ,,r’,.ms’—si.’ r,r’in’,c’’ on new benchmark data, were revised — irs,. L’i s..li..it:n,i ~ iii. •. ‘5 I’~l,L’’ir!ri.,rh’ —‘‘it... s.s:d . try,...: ‘I,: .,.,.,,.~, rhnl,.,l’ ., downward by $1.2 billion. The net of :1..’. ‘iii.. .i—— .ltin,uil i.Ll” .5—. P,,as,... r..rsi.—r.: tic’ ,‘..r.i’ii’,i.,slt :1:1, these two corrections raised the de- 5 , .. t.i.,ii . .~ i.~ h .. 5.5,5.. —s—znI‘‘.:‘,i ‘‘I ,,. b’ i.,r,ia’i .‘ I ii, ~.,,r’. mand deposit component of the money .. . i ..s,~,i- ‘I. ‘‘.1::. Is,’,. ,:c r’’.s:—sl:,. 5 supply (before seasonal adjustment) by $6.7 billion in the sample week. ri, :i,li.s—’ a,,

Magnitude of the Revisions: Levels and Growth Rates of Money The accompanying chart of monthly data for the “revised” and the “old” money supply series from 1967 to the present illustrates the effects of the recent revisions.0 Underestimation of the old money supply series has been building up since mid-1968, and has widened more rapidly since mid-1969. However, com- parison of the levels of the old and revised money supply data would not provide an accurate assessment of the effects of the recent revision on the influence of monetary actions in the past few years. Empirical

obtain additional data from agencies and branches to allow for checks written by them that were making for inappropri- ate cash items as a result of the intermediary role of these institutions in intemational transfers. Such data have been reported daily since October 1 and will be available on a continuing basis.” TM Two other much smaller sources of understatement of demand deposits resulting from banks’ practices in accounting for Eurodollar repayments were identified and eliminated by a change in accounting practices of certain banks. 0 The recently revised money supply data are referred to as the “revised money supply series,” and the former data are referred to as the “old money supply series” only as an aid to exposition in this article.

Page 8 FEDERAL RESERVE BANK OF ST. LOUIS JANUARY 1971

Toble I) Vt MON T UPPLY ePc 0046501 33 0 HAN 175914 111 1M98165 816L60M6 OP MONTH 00Lt4 5—69 9169 699-690’- 11 170 7 104-1 706-10110 8-10 10’t9-’7011-’74

6—6 4. 202,4

7 4. 42 20 .1

49 20 0.62. ____- ______2 6

9—6>9 1. 0.8 ‘.9 12 - -— 02e

10-64 1-9 1.2 .2 1. 2.4 2034

11 69 1.9 5. . 1,8 .11.5 203,5

12 9 1.7 1.2 0.6 1. 1. 1-2 .6 203.6

110 27 .4 .1 3. 4.0 5.1 9. - —-— 205.2

2— 0 - .9 1.6 1.21.9 2-1-9 . .7 4. 264.

10 3.0 2- .1 3.4 . 4,1 4.6 . 4. 13.0 --06.6

4,70 3.6 .-4. 7 5,1 . 7.5 6. 11.7 10.7 6.

-70 .3~6 3.4.2 ~S 4 ~265. i.~ .3 3. 2.3

77 .8 .7 .7 4. 4.1 4,9 . 6. 5. 7.3 5.9 4.5 4. 5.9 —- — 2306

8.-la 4.4.0 9.9 4. 4.. 5.1 .1 .6 7.3 6.1 .1 5.1 6,5 7.5

9”lO 4.1 41 4.1 4.6 4.9 2 ‘. .1 5. 7.1 .1 s.3 5.3 6.2 6.4 6.8 212.e

107 4_a .9 3.9 4~4 4. 4. .1 s.6 .1 6. 5.4 4.6 4.4 4.9 4.6 3.4 1.1 2’13.0

fl’20 .9 .8 3. 4.34. 4.2 4.9 .2 4.9 .9 5.1 4.3 4.2 4. 4.2 3.2 2.0 2.9 213.5

210 4,0 4. 4. 4,4 4,6 , 5. 5.4 5.0 6.0 5. 4.6 4.5 4. 4.6 4.0 3.4 4.6 6,4 14.6

— — 7 9 69 64 fl - I t-1t~ 20 77 “lU “1 ‘19~r-10 ,“lrlt—iO it it -

5, MON K

I V PP 4590 103 1594 4

1NA 2 lION 111054505’ 810 0 1,485 6 4-6 6426 9 1061192 10 “70 “10 70 —70601—70 8’7’0 970

4-’ó 2 148.1

5”69 4.7 1.2 198.

6 69 4.. 4,3 199.-fl

16 . 2.4 .1 1.8 199.3

869 2.7 I. 1. 0. 5. 199.0

9-69 2.2 1.1 1.1 0.1’ 0.9 0. ______- ______1,99.0

*0-69 2.0 1.0 1. 0. .4 0 0.6 - 199a

*169 I. 5.0 1. .4 _ .6 . 1.2 — 199.3

12—6 1.1.1 1.1 .60.4 .1, I. 1,8 ______- ______1996

170 2.6 .0 .1 1. 1.8 2,6 . 4. . 9.4 201.1

270 1.4 .7 0.7 0.2 0. 0-3 0.4 0. .0 0.9 I .2 199,3

37 .4 1.51’ 1.7 1,7. 2. 2.9 3.3 3,91.2 14.1 2015

470 . 2.6 2. .6 2.7 3. .7 4.4 4.9 .7 4.4 1.7 11. 203.3

6-70 , 2. .8 .7 2. 3. .7 4.2 4.7j~~J 4.2 9,6 7.4 .6 - 203.9

670 2.8 42.5 3 ,4 2.8 3.1 344.7 4. .0 6.6 4. 0.9 1,8 203.6

7—70 .8 2.5 2. .5 2. .9 3. 3.5 .8 4.1 3.2 6I 4.2 2,0 1,2 4.2 2043

8—70 .3 .0 3.1 3. 3.1 3.5 3. 4.2 4. 4.8 4.2 .8 5.4 4.0 4. - 7.3 10.5 206,0

9—70 3.22.9 3.2.9 3. 3 3.6_- .9 4.2 4.4 3. 6. 4.7 .5 3.4 5.2 .1 1.2 206.2

1070 2.. . 2.7 2.6 2.7 3.0 . 3.5 3.7 .9 3_3 5.1 .9 2.7 2.5 3.6 3.4 0.0 —1.2 660

4’69 ‘-59 66 1- 6 3-69 I -WI 1 76 “1 7 70 4”r~ 3—70 6 ‘10 1’ 70 6 tO’ 4—16 5 512 1 N I

Page 9 FEDERAL RESERVE BANK OF ST. LOUIS JANUARY 1971 studies provide evidence that, for purposes of assess- in money and Government expenditures on the other, ing the impact of monetary developments on the econ- it is possible to estimate the changes in GNP which omy, it is appropriate to look at the changes in the are implied for the future under alternative assumed rate of growth of money over the past twelve or more growth rates of money. The same assumptions about months. future Government expenditures are employed in each The growth rates of money indicated by the revised case, and it is assumed that there is no difference in other factors that influence GNP. In such illustrations, series for 1968 and 1969 are not sufficiently greater the relative sizes of the projected changes in GNP than the respective growth rates indicated by the old series to warrant reassessment of the influence of under various assumptions concerning the future growth rate of money are important. The absolute monetary actions during those two years. The growth level and the changes in the projected values for GNP of money in 1968 (from IV/67 to IV/68) was at a are naturally subject to many factors not provided for 7.4 per cent annual rate for the revised series, com- in this procedure, such as the duration of an automo~ pared with a 6.8 per cent rate in the same period for the old series. Similarly, the revised money series bile industry strike. rose at a 3.8 per cent rate from IV/68 to IV/69, not much faster than the 3.1 per cent rate of increase Monetary Actions in 1970 of the old series in that period. As noted above, the growth rates of money for The significance of the recent money supply revi- 1968 and 1969, according to the revised series, were not much greater than the rates indicated by the old sions depends upon the impact of the revisions on the rates of change of money during 1969 and 1970. series. Consequently, assessment of the thrust of monetary actions during those two years is little affected Table II contains two “rate-of-change triangles” show- ing the growth rates of the revised and the old money by availability of the revised series as opposed to the supply series from various initial months to various old series. terminal months in 1969 and 1970. To read the tri- The effect of one’s assessment of the thrust of angles, observe that the rate of change of the revised monetary actions in 1970 bears closer analysis. From money supply series from December 1969 (on top IV/69 to 111/70 the growth of money was indicated and bottom horizontal axis) to May 1970 (on left by the old series to have been at a 4.2 per cent vertical axis) was 6.7 per cent. The rate of change of annual rate, and is now shown to have been at a the old money series in the same period was 5.2 per 5.5 per cent rate by the revised series. A relevant cent. With the aid of these triangles, the reader can question to pose at this point is whether one’s conclu- choose any beginning and ending month he considers sion about the influence of monetary actions on the relevant, and compare the impact of the recent revi- future growth of total spending, and hence prices and sions on the growth rates of money. unemployment, would be much affected by the availability of the revised series. Revision of Money and Assessment of the Influence of Monetary Actions on GNP By employing this approach, it is possible to test ~ Analytical %~P)roach whether the growth rate of money for 1970 that ap- peared most likely to achieve a given growth rate of It is useful to employ a consistent analytic frame. total spending would have been different at the end work to analyze the implications of the revised money of 1969, if the revised money series had been avail- supply series on the implied course of total spending. able at that time. Using statistical relations estimated Such an analytic framework is available in which from data available through the end of 1969, projec- changes in gross national product are statistically re- tions were made of the growth paths of GNP for the lated to current and lagged changes in the money sup- four quarters of 1970 based on alternative assumed ply and high-employment Government expenditures.10 (constant) growth rates of the revised money series. These projections were then compared with similar After obtaining a historical relation between projections based on the san-sc assumed gro\vth rates changes in GNP on the one hand, and changes of the old money supply series.” 10 See Leonall Andersen and Keith Carison, “A Monetarist Model for Economic Stabilization,’ this Review, April 1970, liSpecifically, data for quarter-to-qunrter changes in the old pp. 7-25, for discussion of a procedure whereby alternative series from 1953 through 1969 were used to estimate a constant rates of growth of money are used to simulate the statistical relationship with quarter-to-quarter changes in relative impacts on projections of various measures of eco- GNP in the same period. Next, alternative assumptions nomic activity. about the growth rate of money during 1970 were used to

Page 10 FEDERAL RESERVE BANK OF ST. LOUIS JANUARY 1971

The results were very close between each growth Tabfe Ill rate for the two series, indicating that the availability PROJECTED CHANGES IN GNP of the revised series at the end of 1969 would not Using the Revked Money Supply Series have influenced substantially the selection of the de- and the Old Seriesi sired growth of money for 1970. For example, based Annual Rates of change on the actual growth of the revised series during Revised Series Old Series 1969 and an assumed constant 5 per cent rate of li/ID lActuali 16.1 1 IV 70 64 growth of this series during 1970, the growth of GNP 1,71 6.3 5.9 was indicated to be 6.1 per cent from IV/69 to II 71 6.3 6.4 111,71 89 9.2 IV/70. This compares with a 5.8 per cent growth IV, 71 6.0 6.3 0 of GNP for the same period as indicated by the Dollar c’ionge from Proc-ole Quarter actual growth of the old series in 1969 and an ex- Revised Series Old Series trapolation of that series at a 5 per cent rate for 1970. II 70 (Actual) ($14.4) IV 70 $15.4 $12.9 1.71 15.4 14.3 It now appears that the actual growth of GNP II 71 15.5 15.7 111,71 22.2 23.0 during 1970 was somewhat less than 5 per cent. A IV/71 15.4 16.1 5 per cent rate of growth of either money series nun’’ sql S h’ii inip~.-srns,nT nu-rI,-..Iii-!,ti.-sr,. Ihs-..stn..~-rs .~-sh•r indicated a faster GNP growth during 1970. However, Li- ir:.n1 III 355 1.i fl’~. I~~cp.cift.,r. . ~r. • ‘‘in it should not be surprising that the actual growth of hr-of:! T1.ard .f.,,5:4f•,. ;irv-rni...-~.j 1 GNP fell short of the projections based on 5 per Uil:-nns— .5 d:.s:uns at issue r.iI., cent growth of money. The actual growth of GNP in the second half of 1970 was substantially dampened rate of increase was assumed in the respective money supply series from 111/70 to IV/71. by the automobile industry strike, but, since there is no provision for the effects of a strike in this proce- The table shows that GNP projections for IV/70 dure, the actual should be less than the projected. and 1/71, obtained using the revised money supply Furthermore, the procedure is based on historic aver- series, are higher than those obtained using the old age relationships between changes in GNP and money supply series. The GNP projections based on changes in money and Government expenditures the old series for these two quarters are strongly during a period (from 1953) in which there have influenced by the relatively slower growth of money been several “business cycles” of varying lengths in 1970 indicated by the old series. The GNP projec- and degrees of severity. tions for the period from the fourth quarter of 1970 through the end of 1971, using a 5 per cent growth rate of either money supply series, are approximately Monetary ,Actsons •in 1971 the same. Table III shows the projected quarterly changes in The revision of the money supply data has per- GNP from IV/1970 to IV/197l as calculated for the mitted a reassessment of the predicted strength of revised money series and for the old series (based on economic activity in the near future. However, the data available through 111/70). A 5 per cent annual revision has not had a noticeable influence on pre- dictions of the effects of monetary growth on economic activity over the coming year. On balance, if the obtain quarter-to-quarter changes in money for 1970, beginning frbm the actnal level of money (old series) in the goals of policy have remained unchanged, the com- fourth qnarter of 1969. These assumed changes in money in parisons presented here do not support any conjecture 1970 were then used, together with actual changes for money in 1969, to compute the projections of GNP for 1970 that monetary actions in the near future should be implied by each alternative growth rate of the old money altered substantially from actions that were deemed series during 1970. Finally, the entire procedure was re- peated using actual changes in the revised money through appropriate based on the old series. 1969 to estimate a statistical relation with changes in CNP for the period, and to make projections for 1970. This article is available as Reprint No. 62.

The Appendix to this article begins on the next page.

Page 11 APPENDIX

The following Appendix provides a technical analysis of how transactions involving Edge Act corporations caused an underestimation of the money stock series prior to the November 1970 revision. The example transactions used in this analysis should be viewed as a typical sequence of entries which would affect the measurement of the money stock.

The examples used draw heavily on a paper by Irving Auerbach of the Federal Reserve Bank of New York: “Edge Act Corporations: Some Problems For U.S. Bank- ing and Monetary Statistics.”

The purpose of this Appendix is to illustrate, through First Day the use of “T - accounts,” the type of transactions involving Edge Act corporations which have resulted in an A Chicago bank desires to borrow funds for a day, understatement of the money stock, A key to under- say $1000, from a European bank (possibly a branch of standing the examples used is to remember that one a U.S. bank in Europe), and instructs its foreign branch asset account of commercial banks (Cash Items in the bank (say- in London or Paris) to borrow Eurodollars Process of Collection) and one liability account (Due and have the funds paid to the Edge Act which will to Banks) are both deducted from the banks’ gross transfer the amount to Chicago. The foreign branch of (total) demand deposits in order to obtain the demand the Chicago bank arranges the loan from a German deposit component of the money stock. Also, demand bank, which notifies its New York correspondent bank deposits of foreigners at U.S. commercial banks, whether to draw a check on its account payable to the Edge Act. foreign individuals, banks, corporations. or governments, The initial transaction for the first day is by the New York correspondent of the German bank, which issues an are included in the demand deposit component of the 1 money stock. Officers Check payable to the Edge Act (and is delivered immediately to the Edge Act). This New York bank In the illustration, a Chicago bank will borrow Euro- increases Officers Checks Outstanding and decreases the dollars for one day from a German bank, using the demand deposit account of the German bank, denoted services of an Edge Act corporation, and then repay the as the Deposit of Foreigner account. amount through the Edge Act corporation (hereafter New? rkCorr spond tofCennanfl nk abbreviated to Edge Act). The Edge Act is located in New York City, but performs services for banks elsewhere Deposit of in the United States as well as for Eoropean banks. For igner $1000 ______Officer Checks No et For the illustration, it will be necessary to report the Out tanning 31000 fife t on transactions of two New York banks. One New York (p yable to Edge Dciii nd bank is the “correspondent” of the German bank which Act) Deposits is lending funds to the Chicago bank. The other New York bank is used by the Edge Act to clear funds, that The Edge Act immediatel) takes the Officer. Check is, to receive transfers from the account of foreign lend- to its clearing bank in New York and deposits the check ing banks and to repay borrowed funds to the account to its own account. On its own books the Edge Act of foreign banks. In other words, the Edge Act maintains increases an asset account, Due from Bank (the New a checking (demand deposit) account at the New York York correspondent) waiting for the check to clear, and (clearing) bank for purposes of conducting international also increases a liability account, Due to Bank (the transactions as a service to U.S. and foreign banks. Chicago bank).

The effects on the money stock when a U.S. bank 1 A change in the Federal Reserve Regulation D, effective borrows Eurodollars for one day using an Edge Act July 31, 1969, requires that issuing banks include such items corporation will be illustrated by ‘f—account entries for as “Officers Checks,” used in the borrowing and repayment three successive days. of Eurodollars, in gross demand deposits.

Page 12 FEDERAL RESERVE BANK OF ST. LOUIS JANUARY 1971

Eg At spa -o causes a reduction of demand deposits of $1000, since “Cash Items” are also deducted from gross deposits to Du oin D fink 1000 NoNet obtain tile money component. The decrease in deposits Bank 000 (the wi Eff ton occurs because there was no offsetting rise in net deposits. rom N. carte- h’e g ) Dema d Stated simply, since the increases in both the asset and spon toflend r Deji st the liability accounts of the clearing hank are deducted from gross deposits, and since no other bank closed on At the sam time the Edge Acts cle-iming b-ink in the first day with a net increase in demand deposits, the creases all ass t account, C ish Items in Process of Col demand deposit component of money has fallen $1000. lection nd increases m Ii hilit , Due to Bank ( Edg Act). Second Day 1 k ank of On the second day the Officers Check will clear, re-

tfiO serves will he transferred first from the New York com- Ga h it m in Pro Dii aS k 1000 Demand e pondent bank to the clearing bank, and then to the o lie n $1000 ct dge A ) Deposits Chicago bank. Meansvhile. the Chicago hank will initiate repayment of the loan through the Edge Act. At the end of the second day the demand deposits will still be re- In the meantime, the Edge Act notifies the Chicago duced by $1000. The day’s transactions are shown in bank that it has borrowed $1000 for one day from the steps. German bank, and that collection of the funds is in - progress, so the Chicago hank records an asset entry, First, when the Officers Check clears, the New York Due from Bank (the Edge Act), and increases a nos- correspondent loses reserves of $1000 and reduces its deposit liability, Due to Foreign Branch. liability account, Officers Checks Outstanding. Ns York s-repondn of ermn Bank fian D fom D Forign N II ‘,(5\t ‘~1IfI)() Officer (The Demand oat nding 1000 Depo its a 1000 l3rnh $1000 Effe ton Ør dg c) (ownovrsas Do Decreas hr ch~ Dpsst At the s-un time the clearing bank gains the re At the close of business on the first d-is the entries ser es and reduces ts Cash Items in Process of Collec- tion b’v $1000. recorded in the above T - Accounts show th-it the money supply has decreased by $1000. To see this, note that there is no effect on the net deposits of the New York cor- N wYorkCl rsngfiankof respondent of the German bank, since both Officers Edg A ~t rpo on Checks and Deposits of Foreigners are included in the B serves $1000 Dem md demand deposit component of money. Also, the deposits Ch1 i Pro a- Depo its of the Chicago bank are not affected, since the liability account, Due to Foreign Branch, is not a deposit ac- of ol ion $ 000 Increase count and therefore does not enter into the computation Upon receiving the esen es the clearing bank In- of the money supply series, and the asset accormt, Due itiates a transfes of funds to the Chic igo b’mnk so the from Bank, does not affect the deposit component of fonner bmk loses the mese yes it just received and re ~ Furthermore, prior to the November 1970 reduces a lablitv Due to Bank. vision of the money supply data, the transactions of Edge Act corporations were not considered in computing private demand deposits. N wY r Clearing Bank of Edge A rporat n Finally, the clearing hank of the Edge Act has two slosh) Do to Ban $1000 No Net entries that affect deposits. An increase in the liability (due toE g ct) Fifeeton account, Due to Bank, causes gross demand deposits to Dem nd rise hut, since these “interbank deposits” ai-e subtracted D posits from gross deposits to derive the (lemand deposit coin- ponent of money, there is no net increase in demand ~s this transfer occurs the Chicago hank reduces an deposits from this entry. Furthermore, the increase in asset, Due from I3ank to mitch the increa. e in resers-es the asset account, Cash Items in Process of Collection, -md the Edge Act clears tIm transaction from its books.

tm Liabilities due to its own foreign branches are not considered hi g fink deposits by the parent hank. The parent is not required to hold reserve balances against these liabilities (as they are Bsrv ‘1000 N Net against “due to domestic commercial banks’), and these Dufmn Eifton deposits are not considered to be a part of the “private de- Ban 1000 D mand mand deposits in the hands of the public.” D osi

Page 13 FEDERAL RESERVE BANK OF ST. LOUIS JANUARY 1971 deposits were reduced at the end of Day 1, they remain d C at the lower level at the end of Day 2.~ D from o~B 1000 oNet Sank I000 Effec on Domand Third Da - Depo t 4 To initiate repayment of the borrowing of the prem ious As repayment of the Day 1 loan is cleared on the third day, the Chicago bank tells the Edge Act to make ade day, the money stock will be restored to its original $1000 greater level, assuming no new transactions through posit to the account of the German bank (at tIme latters Edge Act corporations have occurred in the meantime. New York correspondent hank) . As a provision for thi repayment, the Chicago bank increases one liability ac- To cover the Officers Check written by the Edge Act, count, Due to Bank (to the Edge Act), and decreases the Chicago bank makes a transfer of funds to the ac- comit of the clearing bank of the Edge Act. The Chicago another liability, Due to Foreign Branch. bank loses reserves and reduces its Due to Bank (Edge ‘a B Act) liability account. The Edge Act reverses its prior entries to clear the transaction fsom its books, and the Due B00oN clearing bank of the Edge Act gains reserves and (uto gAt~ If o increases a liability account, Due to Bank (to New York Due F*t’agn Dem d correspondent of German bank) - ]~r Ii 1000 Deposit hr go Ba The Edge Act writes an Officers Ch ck drawn on its account at its clearing bank and increases an asset Due from Bank (Chicago). d 00 Doefrtnnliiplk Offieersc kg o (Ii go) $1000 100 ( -abl rim 1) d~ 1) rum aIm, 1000 0 - $000 on The check is delivered to the New York correspondent mand which increases the German bank’s account (Deposit Deposits of Foreigner) and increases its Cash Item in Process of Collection account. k-tearing if Edg ospo i k mr tof ermsn]?m k as Itonish-iP 1) sitof o lIe j000DoeBan+1000 ~et otColletition 100 Foreigner $100 if cm on (NwYk PS ( ennubalt) Demnan orr en) Depots Depos

~t the end of the second d the New Iomk corres- Upon receiving the reserves from the Chicago bank, pondent has had an offsetting lucre ise and decrease in the clearing bank makes a transfer of funds to the New deposits, with an increase o cash items resulting in a York cormespondent. The entries for the clearing bank decrease in the demand deposit component of money. are a decrease in reserves and a reduction of the account, The clearing bank of the Edge Act reduced its cash Due to Bank. The entries for the New York correspond- items, which caused the deposit component of money ent of the German bank are an increase in reserves and to rise at that bank, since there was no corresponding a reduction of Cash items in Process of Collection. decrease in deposits (again, a change in the Due to Bank liability does not, by itself, result in a change B f in the deposit component of money). The entries t orp lion of the Chicago bank are a reduction in the nondeposit account, Due to Foreign Branch, which has no effect ,t s’c-’ —1001) tin Bank $11000 Not at all, and aim increase in the Due to Bank liability ( wYok if account, which increases this bank’s gross demand esp ) Demand deposits, then, it is subtracted out once again to compute ti posits the deposit component of money, resulting in no net effect. Again, the Edge Act entries did not enter into the 3 computation of money. The reader may note that if the Chicago bank had borrowed another $1,000 on the second day all of the entries for the On balance the above transactions for the second day first day would be repented in addition to the above entries for Day 2, and the deposit component of money would be do not result in a change in the denmand deposit cciii- understated an additional $1,000. This point will be discussed ponent of money cornpared to t/me first day. Since demand again at the end of this Appendix.

Page 14 FEDERAL RESERVE BANK OF ST. LOUIS JANUARY 1971

tar-k rr dentitf 0 Bk dollar borrowings of the example (Chicago) bank, if the bank were to borrow the same amount every day, for Beg e 000 Demand one day. In the illustration used, the original amount bor- Cash ten-is Deposits rowed from the example Cennan bank was already in- f oil eb n $1000 Increas cluded in the private demand deposit component of It hould be clear that the depo it component of money. If the original $1000 had been, for instance, a mone’ rises at the New York correspondent bank, since deposit at a foreign branch of the New York correspond- the asset it deducts from gross demand deposits, Cash ent bank, and the amount was transferred from the branch to its New York parent when the loan was made, Items in Process of Collection, is reduced while theme is then the deposit component of money would not have no corresponding decrease in deposits. The entries for been reduced on the first day. The fall in deposits at the Edge Act and the other banks have no effect. The demand deposit component of money is returned to the the clearing bank would have been matched by a tem- porary rise in deposits at the New York correspondent. level at the beginning of the first day. The demand deposit component of money would then fall on the second day, as the amount is both cleared to l’o.s-sibility of “Doub/e Underestimation” Chicago and repayment is initiated through the Edge Act. As indicated in footnote three of this Appendix, the Similarly, if the original amount held by the Cerman example transactions involving an Edge Act corpora- bank had been a time deposit at its New York cor- tion, which illustrate how an understatement of private respondent bank, the demand deposit component of demand deposits can occur, could result in deposits money would not have been reduced until the second being understated by twice the amount of the Euro- day.

Page 15